Applying blockchain in securitization

After months of analysis and consultations with various industry constituents involved in different stages of the securitization lifecycle, there is little doubt that blockchain and smart contracts (a key technology that enables many blockchain applications) hold such promise.

Blockchain has the potential to streamline processes, lower costs, increase the speed of transactions, enhance transparency, and fortify security.  The industry is at an early stage in the evolution of blockchain for structured finance, but blockchain, along with smart contracts, promises to transform many activities in the securitization lifecycle. The question for the securitization industry is not if, but when?

Why blockchain?

The technology’s potential to streamline processes, lower costs, increase transaction speed, enhance transparency, and fortify security could impact all securitization lifecycle participants — from originators, sponsors, and servicers to ratings agencies, trustees, investors, and regulators.

The combined impact of blockchain benefits could lower risks in the securitization market as a whole and lead to greater investor interest. This, in turn, would improve prices, volume, and spreads. With better and more transparent information, regulatory compliance could also be simplified and market failures would become less likely.

Faster, easier, and safer transactions

Blockchain’s capacity to bring all market participants onto a single platform, where sharing information is simple and all changes leave an immutable audit trail, could facilitate every aspect of structuring a security. It would create a single source of truth which all participants could use for analysis and forecasts.

Implementation challenges

With new technology comes new risks. Securitization is an important source of capital not just for the financial sector, but also for the wider economy. Any change in the industry’s market structure, including the supporting technology infrastructure and safeguards, should only be taken with extreme care.

Consultations with industry experts and blockchain specialists have helped identify a range of issues that need to be resolved before the industry can successfully transfer operations to a blockchain. These potential risks broadly fall under three categories:

  1. Data security and privacy. With so much information on the same technology platform, a successful cyberattack could be systemically devastating. And privacy issues may arise since blockchain’s distributed structure shares and stores sensitive data on multiple nodes.
  2. Technology that isn’t yet fully vetted. Blockchain is still a relatively new technology. And although several blockchains have multi-year track records, many smart contracts and other blockchain applications have not yet reached a demonstrably bullet-proof level of reliability.
  3. Legal and regulatory uncertainty. Regulators, starting with the SEC, will have to accept blockchain’s use for securitization, including—but not limited to—blockchain’s methods for entering, verifying, and protecting data. One possibility is that a new monitoring environment will be needed with regulatory presence on the blockchain. Regulators will also have to rethink how financial institutions should integrate blockchain into regulatory reporting.

The new securitization lifecycle

What would be the result of this new system? With perfect data, lower costs, increased safety, and quicker payment streams, investor interest would grow even in securities that previously were considered opaque and, therefore, high-risk. Trading volume would rise, spreads fall, prices improve, and the growth in safe and stable securitization would increase the supply and lower the cost of credit to the broader economy.

Should a scenario of extreme stress arise because of macroeconomic conditions, servicers, rating agencies, and investors could all take measures based on verified, real-time data while blockchain’s immutable data would eliminate the issues of poor documentation and fraud that troubled the industry during the last great downturn.

The securitization industry would be lower cost, more efficient, larger, and more resilient to fraud and downturns.

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